Happy Volcker Day!

Author:
Publish date:

I guess this is a thing? Today is the last day to submit comments on the Volcker Rule so hurry!* No less than Paul Volcker himself was roused from 25 years of slumber to submit his own comment, and while he was up he laid a gleeful smackdown on European governments. You may recall that some clients had some concerns about the Volcker Rule reducing liquidity, with some of those concerns being less sympathetic than others, and foreign sovereigns were among the noisiest complainers. Volcker is having exactly none of it:

There is a certain irony in what I read. In Europe, there are plans to introduce a financial transaction tax, justified in part by officials because it puts “sand in the wheels” of overly liquid, speculation-prone securities markets. ... How often have we heard complaints by European governments about speculative trading in their securities, particularly when markets are under pressure?

So, ha, fair. There are other comments ranging from sort of what you'd expect from a guy calling himself Anonymous ("When are you people going to do what is right by your country? You destroy everything thousands of people fought and died for? How dare you counterfeit money for thieves, but NOT for suffering AMERICANS, Oh and for your WARS for PROFIT, prisons for PROFIT when we live in a FREE society??" etc.) to sort of what you'd expect from people calling themselves the Securities Industry and Financial Markets Association, the American Bankers Association, the Financial Services Roundtable and the Clearing House Association (this one is 173 pages long and takes no explicit view on counterfeiting money for thieves though I'm going to guess they're okay with it).

My natural sympathies are with the SIFMA-et-al. letter** but who is going to listen to the American Bankers Association, so let's see if we can't find some clients to freak out about the end of liquidity as we know it. As a typically persuasive yet slightly incoherent example of the genre, I enjoyed MetLife's letter:

Lower liquidity in the market would most likely result in higher costs for issuers of debt, as investors will need to be compensated for buying less liquid securities. ... MetLife believes that the resulting lower market liquidity will also have a profound impact on investors in the debt markets. ... First, investors will demand higher spreads in order to compensate for this lower liquidity. This new "liquidity premium" will result in an almost instantaneous decline in the value of our currently held investments. The overall impact of this on the corporate bond market alone is estimated to be $300 billion. Second, transaction costs will increase as bid-offer spreads increase to compensate for this shift in liquidity. Third, long-term investors, such as MetLife, will be forced to keep their portfolios more liquid and avoid positions that are likely to be harder to sell during credit downturns. This risk avoidance is one reason some borrowers may lose access to the market.

Quick aside: $300 billion? According to SIFMA there is $7.74tn of corporate debt outstanding, with supposedly an average maturity of 12.9 years. So that's almost 4 points per bond of value lost due to the Volcker Rule. Say weighted average duration is 8 years (??) you get almost 50bps of increased spread for the Volcker Rule. That ... I mean, okay, sure, why not.***

Volcker's piece in the FT is a little unfair because he starts with "I didn't hear anyone complaining about liquidity when we had Glass-Steagall" but of course then there were lots of large independent investment banks that could make markets, and now there are none, they're all commercial banks of one flavor or another. (Or Jefferies or Citadel or whatever. But not GS or MS or Bear or Lehman or First Boston or Drexel or etc. etc.) But his claim in his comment letter that there "should not, however, be a presumption that ever more market liquidity brings a public benefit" is plausible, or at least will sound that way to Italian treasury officials.

And it's interesting that the defenses of liquidity come mostly from debt investors like MetLife or AllianceBernstein rather than debt issuers, European governments notwithstanding. Investors who manage money for life insurance funds, pensions, etc. should be the least sensitive to market liquidity, and in fact they tend to be the more buy-and-hold investors in debt instruments compared to, say, hedge funds.**** Let's say it's true that the Volcker Rule will blow out the cost of debt by 50bps for all corporate issuers (while leaving Treasury rates unch'd because of course Treasuries are exempt from the Volcker Rule). The corporate bond market would then have a $300bn mark-to-market loss, which MetLife would take a big chunk of - but of course MetLife can live in a hold-to-maturity world if it wants to, and if that loss is purely liquidity premium and MetLife is just salting away bonds to pay death benefits in 30 years, it won't ever actually lose that money. Meanwhile, new issues will have to come with 50bps higher rates, helping MetLife make more actual money in interest payments - again without costing it anything but some liquidity it doesn't really need. If you believe that the Fed's low interest rate policy hurts savers, and you believe MetLife's claims that the Volcker Rule will raise bond spreads without increasing credit risk, then I guess you'd conclude that the Volcker Rule is a good way to help savers. Like MetLife's customers.

If you're sympathetic with the banks' claims that the Volcker Rule will reduce liquidity, and that that's a bad thing, then you probably won't be persuaded by Volcker's own defense of his rule. But I'm not sure you'd find all that much support in attacks on that rule from nominally buy-and-hold investing clients claiming that the rule will drive up costs for issuers. That claim might be more convincing coming from issuers - particularly, as Volcker points out, from issuers who don't spend half of their time complaining about too-liquid markets in their debt.

Volcker: Foreign critics should not worry about ‘my’ rule [FT]
Financial Trade Groups Want Volcker Redone [Deal Journal]
Volcker Rule Comment Period Ending: What’s Been Said So Far [Deal Journal]
Volcker on Volcker: The Letter From Paul [Deal Journal]
Tons of Volcker Rule comment letters [FRB]

* Fun fact: today is also the day that I have exceeded the combined tenures oftwo of my notablepredecessors. Now I can retire happy, and also immediately.

** Actually with the Anonymous guy too come to think of it.

*** Here's why not. SIFMA also shows $18bn of daily trading volume in corporate bonds, or $4.5tn a year, meaning that the average bond turns over about 0.6x per year. You could simple-mindedly calculate that 50bps of additional annual spread means that the expected additional transaction costs imposed by the Volcker Rule would be 80bps per trade. That's more than the total underwriting fee for a new-issue investment-grade 10-year. That seems implausible.

**** So MetLife's portfolio turns over roughly 0.3x per year ($353bn of fixed income portfolio vs. maybe $100bn or so of sales and maturities [$80bn in 9 months] - and that includes "turnover" in the form of maturities as well as sales), maybe half the market average, and is mostly classified as available-for-sale, meaning that mark-to-market changes don't flow through accounting income.

Related